A Three-Gap Analysis of Malaysian Economy

Abstract

Malaysia, setting out to transform its economy through industrialisation to
become a fully developed country by 2020 must provide for all of the resources
required as best as it can. The key question pertaining to economic growth goal in
Malaysia is the present and future configuration of the resource gap constraints which
can be influenced by factors such as reliability of foreign capital inflow, strength of
crowding in and crowding out effects, and the imperatives of the constraints on the
process of economic development.
This thesis attempts to elucidate the above mentioned structural questions, to
identify their solutions as well as to examine the extent of macroeconomic constraints
faced by Malaysia as it undertakes economic transformation. Two as well as three-gap
approaches have been utilised to identify the dominant resource constraints limiting the
target growth and to estimate the future resource requirements needed to achieve the
pre-determined target. Particular attention is given to the impact of foreign transfers on the rate of growth in potential output. In addition, the study will examine the saving
behaviour of the Malaysian economy. This will be done using the multivariate cointegration
approach followed by an error-correction modelling to investigate the saving
behaviour in a dynamic framework.
The empirical findings of the saving analyses indicate that maintaining a stable
macroeconomic condition is critical for mobilising savings, encouraging domestic
investment and laying the foundations for sustained economic growth. Among the
macro variables exports and tax level appear to be more significant in explaining the
saving rate in Malaysia. A number of other variables including interest rate, dependency
ratio and rate of growth are also important. The dependency ratio has been found to
exert a negative effect on rate of saving. The empirical results have confirmed the
adverse effect of foreign direct investment (FDI) on savings, suggesting that strategies
aimed at reducing the FDI (and thus debt burden) would help to raise domestic saving.
The results of two-gap analysis tends to conform with that expounded by the
Neo-structuralists which claims that the dominant constraint in most developing
countries is foreign exchange gap caused primarily by structural disequilibrium or
macroeconomic imbalances. The estimation and projections carried out have led to be
the inference that the trade constraint has tended to be more binding than the saving
constraint. In the three-gap analysis, a sustainable growth of 6.5 per cent per annum
would require an investment ratio of 28 per cent, while an 8 per cent of annually
would growth require 35 per cent investment ratio over the period 1995-2000. With no change in the ratio of interest payments to potential output, 5.58 per cent of foreign
saving (around RM 5 billion) per year would be required for an 8 per cent growth and a
4.1 per cent (around RM 3.2 billion) annual increase would be required for a 6.5 per
cent growth rate annually over the period 1995-2000.